There was a issue raised at mame4all-pi repository that resolved the problem. Apparently there is code that rejects controllers with more than 6 axes.

Here is what I did. In a terminal, type

sudo nano home/pi/RetroPie/emulators/mame4all-pi/src/rpi/minimal.cpp
Comment out lines 168 to 174 so it appears as below.

//	if (SDL_JoystickNumAxes(myjoy[i]) > 6)
//	{
//		SDL_JoystickClose(myjoy[i]);
//		myjoy[i]=0;
//		logerror("Error detected invalid joystick/keyboard\n");
//		break;
//	}

Save and exit.

Next you need to recompile the code so type in the terminal.

cd home/pi/RetroPie/emulators/mame4all-pi/
make

Reboot and your PS3 controller should now work.